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Kos, put the crokery down and step back from the table. [1]

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Date: 2023-03-13

Yesterday our favourite Blogmaster, Kos, noted that banks looked likely to receive a bailout, sending him straight to the crockery cabinet.

But with Janet Yellen at the helm of the Treasury, what's discussed in media headlines and reality are two different things and there is no public bailout occurring. Here is a note I've circulated to my investor clients today. I just hope its come early enough to prevent the family china from meeting a hard end on the floor at Kos's house.

As anticipated in our note yesterday, the US Treasury has stepped in to backstop the financial system, ring-fencing depositors at SVB and Signature Bank under the FDIC’s ‘systemic risk exception’ rules while leaving debtholders and shareholders exposed to losses. Both SVB and Signature Bank will be wound up with shareholders and “certain unsecured debtholders” facing losses, while depositors will receive all of their deposits with any deposit shortfall funded by the FDIC’s Deposit Insurance Fund, which had a balance of USD 125bn as of end-2022. The US Treasury noted that any shortfall in the FDIC’s Deposit Insurance Fund would be made up for by a “special assessment on banks” ensuring that taxpayers are not funding a bank bailout. In addition to being able to access the Federal Reserve’s discount window, the Federal Reserve has created another alphabet soup program, the Bank Term Funding Program (BTFP), which will offer banks, savings associations, credit unions and other eligible depository institutions access to funding for up to 12-months in exchange for US Treasuries, Mortgage Backed Securities and other qualifying assets used as collateral. The Federal Reserve will allow banks to post this collateral at par, ensuring the institution will not have to crystalise any mark-to-market loss, but loans made under the repo facility will be made with “recourse beyond the pledged collateral to the eligible borrower” ensuring any mark-to-market loss ultimately resides with the financial institution. The BTFP is under-written by USD 25bn from the US Treasury’s Exchange Stabilisation Fund, which currently stands at USD 38bn.

It is our opinion that the ring-fencing of depositors will quell concerns of a bank run while the decision to backstop deposits via FDIC and a potential levy on banks ensures this is not a bank bail-out with bank equity holders (and any subordinated debt holders) still vulnerable to bank risk; hence any rally in bank stock may prove short-lived. On Sunday we argued “we expect liquidity support to be extended by the Fed in some form” and this has proven the case with the Federal Reserve creating the new BTFP, which is in essence a repo facility, with the twist that banks can post collateral at par. While some have recently argued that US banks are holding substantial mark-to-market losses on their US Treasury holdings, we believe this is only part of the story, with the bulk of bank holdings of US Treasury bonds on their bank books synthetically hedged – swapped back into floating or short-dated debt – as part of the bank’s routine asset-liability management. We view the BTFP facility as being largely there to support regional/community banks who are exempt Basel Liquidity Coverage Ratios (LCR’s) and who may have issues accessing liquidity and/or MTM issues on their bond portfolio. Hence, uptake of this facility may be modest and as the Federal Reserve has recourse beyond its pledged collateral we believe the Federal Reserve is well protected.

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[1] Url: https://www.dailykos.com/stories/2023/3/13/2157756/-Kos-put-the-crokery-down-and-step-back-from-the-table

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